In other words, the interest rate is the ‘price’ for money. A. 10 pts] Briefly describe the expectations hypothesis, and how the liquidity preference theory accounts for the observation that the yield curve tends to be upward sloped, rather than what is predicted by the expectations hypothesis. III. 2. Administrative inflation b. Expert Answer Expectation Theory :It is a interest rate theory and focuses on explaining the term structure of interest rate which is dependent on the shorter term segment This theory is … Preferred Habitat Theory (Maturity Preference Theory) Theories of The Term Structure of Interest Rates Market Segmentation Hypothesis 3. Liquidity refers to how easily an investment can be sold for cash. Individuals require a liquidity pr emium to hold less liquid, longer maturity bonds: there is an associated price discount. It adds a premium called liquidity premium Liquidity Premium A liquidity premium compensates investors for investing in securities with low liquidity. Liquidity Premium Hypothesis: Investors are risk averse and would prefer liquidity and consequently short-term investments. b _____ occurs when there is an excessive demand for goods and services as a result of large increases in the money supply: a. Setting: 1. The biased expectations theory is a theory that the future value of interest rates is equal to the summation of market expectations. If the expectation hypothesis holds, what is the market’s expectation of one-year interest rate two years from now? The Expectations Hypothesis 2. Speculative inflation The Liquidity Preference Theory says that the demand for money is not to borrow money but the desire to remain liquid. This theory is an extension of the Pure Expectation Theory. Liquidity Preference Theory Definition. extra compensation) Why? BF2201 Term Structure & Interest Rate Sensitivity Nanyang Business School 17 Liquidity Preference Theory To hold longer-term bonds, investors may require a liquidity premium (i.e. The percentage change in the associated price discount going to the next longest maturity is always positive. Statement: 1. Interest: Theory # 1. Liquidity Preference Theory 3. The liquidity preference theory holds that interest rates are determined by the: ... d. the expectations hypothesis. Liquidity Preference Theory. The longer they prefer liquidity the preference would be for short-term investments. Unbiased Expectations Theory— (Irving Fisher and Fredrick Lutz). Liquidity Preference Theory. B. This is because the expectations theory of term structure holds with constant term premiums in the form of: f n,t =E t (y1,t +n ) +Λ n: Liquidity Preference (Premium) Theory by Hicks : This theory is one of the two forms of biased expectations theory. Duration measures the price risk of holding a bond. 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